Developing a Trading Plan By Louise Bedford

Money is made as a by-product of following a sound trading plan, and adhering to the principles of money management. If you end up losing a significant proportion of your trading capital due to greed and ignorance, you can no longer trade, and you are out of the game.

What to Include

Your plan must cover some basic issues such as your trading goals and objectives, which accounting structure from which to trade, and how you will handle your positions when you go on holidays. A trading plan must also cover 3 essential areas:

* Entry
* Exit
* Position Sizing

Entry

Decide whether to use fundamental or technical analysis methods to trigger your entry into a position. There is no room for gut-feel in the markets when you are starting out. Over time, you may develop an inkling that a trade will work out well, but this will take many years of successful trading. When experienced traders talk about a ‘gut-feel’, it often means that they have internalised many of the indicators that imply an enduring trend, after years of honing their skills. Trading is about making money. It is not about feeling right. Stop trusting your gut feelings. Traders can only afford to trust their trading plans.

Develop a scientific process for analysing signals, and do not let your emotions dictate your trading habits. You need to define your signal in words so that another trader unfamiliar with your technique can duplicate your strategy. If it’s not duplicatable, it’s not a system.

Exit

Before you place your order, you must decide on where you will exit. I advocate that you use a stop loss to capture your profits and avoid large losses. There are four main ways to set a stop loss:

  • Pattern based stop loss traders will exit trades if the share breaks downwards through a trend-line or a significant line of support.
  • Technical indicators can be used as a stop. A dead cross of two moving averages may trigger an exit.
  • Percent drawdown or retracement methods suggest that if the instrument drops in value by a set percentage eg. 7%, then an exit should be made.
  • Volatility based stops rely on significant changes in volatility past a pre-defined level in order to trigger an exit.

To exit a position in the sharemarket, you can choose to implement one of these types of stops or even a hybrid of any of these methods. Derivatives can use all of these types of stops and more. If you are unfamiliar with any of these techniques, it is essential that you research them to find out the most appropriate stop for your own requirements.

Position Sizing

The key to managing risk is to position size correctly. Buy fewer shares and allow the price action room to move if conditions have become lumpy. Seek risk by buying more shares when in profit, or if conditions are more stable. There are many ways to correctly gauge your position size according to sound risk and money management principles. Whichever method you follow, make it explicit by writing it in your trading plan.


Louise Bedford (www.tradingsecrets.com.au) is a full-time private trader and author of The Secret of Writing Options, The Secret of Candlestick Charting and Trading Secrets. Her new book Charting Secrets has just been released.

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